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November 6, 2013

FRC releases auditor risk reporting standards consultation

The UK Financial Reporting Council (FRC) has published for consultation changes to the UK Corporate Governance Code, guidance for boards of listed companies and standards for auditors covering risk management and reporting.

The new consultation comes in response to concerns expressed on earlier proposals issued in January and the FRC said these new proposals set out afresh how the FRC will implement the recommendations of Lord Sharman’s 2012 inquiry ‘Going Concern and Liquidity Risks: Lessons for companies and auditors’. The Sharman inquiry looked at the corporate governance and reporting lessons to be learnt from the financial crisis.

FRC codes and standards executive director Melanie McLaren said: "The new guidance, and the proposed changes to the Code, highlight the issues that boards need to consider when assessing and managing risk, crucially including risks to solvency and liquidity. We have placed considerable emphasis on the need for robust assessment by boards and on the important role of auditors in ensuring reliable communication to investors."

Some of the main changes proposed relate to:– Broader risk considerations and role of the auditorThe draft guidance sets out boards’ responsibilities for setting the company’s risk appetite, ensuring there is an appropriate risk culture throughout the organisation, and assessing and managing the principal risks facing the company, including risks to its solvency and liquidity.

Under the proposals, auditors will be required, in meeting their current requirement to consider whether reporting is fair, balanced and understandable, to consider and report if they are aware of any material matter in connection with the disclosure of principal risks that should be disclosed.

– Solvency and liquidity risks and going concernIn response to the recommendations made by Lord Sharman the FRC proposes a new Corporate Governance Code provision and related guidance. They establish the need for a robust assessment by companies of how they manage or mitigate their principal risks, including risks to solvency and liquidity, and to explain which if any of those risks have also given rise to material uncertainties for the purposes of reporting on the company’s going concern basis of accounting.

The FRC is, therefore, proposing to remove the current Code provision requiring listed companies to make a "going concern" statement. That statement is focussed on the narrow meaning of assessing the going concern basis of accounting, and so detracts from the broader integrated assessment and description of solvency and liquidity risks envisaged by Lord Sharman.

Industry responseEY UK head of assurance Hywel Ball said: "On first reading, the latest FRC proposals seem to address earlier concerns. For example, we note with interest the FRC’s idea to replace the current Code provision requiring listed companies to make a going concern statement, with an explanation of which principal risks, if any, have given rise to material uncertainties. This plays to one of the key recommendations made by Lord Sharman, to integrate the assessment of the company’s ability to continue as a going concern with its broader risk management processes."

Ball welcomed the FRC’s proposals which encourage boards to explain how any significant failings or weaknesses in risk management and internal control are being addressed.

"But only time will tell whether this proposal, if implemented, results in lengthy or boilerplate disclosures. Such an occurrence would be a lost opportunity," he added.

PwC UK head of assurance James Chalmers welcomed the "integration of the Sharman principles into the guidance for directors on risk management and internal control" and the "focus on culture and behaviour as part of a company’s risk management framework".

"The enhanced narrative risk reporting, including of risks to solvency and liquidity, will enable users to better understand the risks in the context of companies’ business models and help link the front and back halves of the annual report.

"We appreciate that the FRC has responded to stakeholder comment on its previous proposals and has refined its approach," he added.

The FRC consultation closes on 24 January 2014. The FRC expects to issue the final Code, guidance and standards in the middle of 2014 with application for financial years beginning on or after 1 October 2014.

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